Opportunities in emerging markets
We see consumer spending, healthcare, real estate, and information technology as the key growth themes in emerging markets. However, the environment is dynamic. It is influenced by various diverging growth trends, and faces many political and economic challenges including industrialization and the digital revolution. We therefore believe that an active country, sector and security selection, based on exhaustive top-down and bottom-up research, is a prerequisite to add value to emerging markets portfolios.
Low yields have presented a significant challenge to investors for a number of years. We see a moderate US-led reflation which is slow and expect inflation and interest rates to reach levels well below the average of past recovery peaks. While global growth is likely to pick up, yields are still at low or negative levels and we expect them to stay low in Europe and Japan in the foreseeable future.
In our view, there are three paths which could offer potential returns to investors, while endeavoring to avoid assets with low yields and possibly negative returns: 1) adding to higher yielding bond strategies; 2) within equities, a focus on unconstrained strategies; 3) increasing exposure to alternative asset classes.
Toward normalization – the uneven path to growth
July 2016 marked an inflection point from deflation to reflation. Bond yields started to rise on a brighter growth outlook. We expect global inflation, led by the US, to increase very gradually. In our view, the expected rise in US policy rates is likely to be the most modest and gradual normalization in the history of the Federal Reserve. However, the path to growth is likely to be uneven due to various risks, particularly the balancing act which will be necessary to exit successfully from ultra-accommodative monetary policy.
Against this backdrop, after a protracted period during which beta (the market) has dominated returns, we see a shift toward portfolio manager skills (alpha) playing a much greater role in generating returns. As rates go up, the pace of appreciation of equity markets slows. US equities in particular command rich valuation metrics and it is realistic to expect that over a 5 to 10 year forward view returns will be lower than those experienced over the past few years. In this phase of the cycle, every 50 basis points of alpha will be worth gold and the appetite for alpha-oriented strategies is likely to grow.
Sustainable investing also referred to as responsible investment, has evolved from screening out objectionable investments to a modern approach which seeks to create excess returns by investing in attractively valued companies seen as leaders in their field. Sustainable companies achieve this by proactively creating shared value not only with their shareholders and customers, but often with their employees and broader society too.
From our standpoint, successful sustainable investors should not regard sustainability as a mere box-checking exercise. They should seek those companies that can consistently generate financial gains for shareholders, in part by approaching environmental, social and governance issues as opportunities to outperform competitors and generate investor value. Measuring and assessing a company‘s competitive edge requires a holistic approach with the aim of having the most complete assessment of intrinsic value possible that considers both tangible and intangible assets.
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